A Boston Review forum on Government's Place in the Market, with an essay by Eliot Spitzer and replies by Dean Baker and Robert Johnson, has been released by MIT Press in its pocket-sized Boston review series. I love this format. It's exactly the kind of book that would be on sale in the airport bookstore of my dreams (that would be the airport where the security and immigration queues are short, the staff polite to everyone rather than just first class passengers, information about delays is plentifully available and the ground transportation functions….)

I reviewed Spitzer's essay when it was published in the magazine. He says the important tasks for government are ensuring the integrity of markets (including competition), addressing externalities and supporting core values. The two responses are less optimistic about the prospect of a benign relationship between government and markets. Dean Baker has written his own book in this series, Taking Economics Seriously, pointing out the co-option of the structures of government by business in some important sectors of the economy – not least banking, where bankers flaunt their influence (see for example the lead story in today's Financial Times (registration required), 'Push for Truce over banks probe', describing the banks' lobbying effort to influence via government pressure Sir John Vickers' supposedly independent review of banking.)

Spitzer's reply essentially says that anybody who believes in a positive role for government in the economy, in the ways he sets out, can't afford to give up hope of limiting the lobbying and political influence – because the alternative is a return to the illusory idea of 'free' markets. And as all applied economists know, a 'free' market is a meaningless abstraction.

He also says thinking about the core values of our societies is vital: “Oddly, that area of public debate has been largely neglected. We have had too much chatter about mechanics and not enough about objectives, too much about credit default swaps and not enough about basic decency.”

I couldn't agree more.

It's the debate for our times, and it's well worth devoting a flight or train ride to this discussion of it.

For anybody who has any experience in public life, either as a politician or official, or in the private sector working on government contracts, Collaborative Governance by John Donahue and Richard Zeckhauser is an interesting read. It looks at how to navigate the boundary between an activity wholly carried out by the government (national or local), one simply contracted out to the private sector, and public-private interaction in delivering more complex outcomes – this latter is what they mean by 'collaborative'.

The boundary between state and private sector is obviously fluid and dependent on political preferences and accidents of history. There is no single 'right' place to draw it. As the authors note, democratic governments have a unique legitimacy in aggregating citizens' individual interests but in circumstances of complexity where the flow of fine-grained information is important, the private sector will sometimes have the advantage in terms of delivering effectively. Their ideal collaboration has the government set goals for outcomes and work in close partnership with a private organisation for their delivery. When it works, collaborative governance can bring in the productivity, information and also resource advantages of the private sector to deliver public value.

They don't pretend this is easy. On the contrary, they note that private companies can distort activities in order to increase their own financial rewards. They argue that often too little attention is paid to governance arrangements and that collaborative partnerships mean more rather than less work for the government officials involved. However, they argue that governments should try because of their legitimacy in determining what creates public value. They are rightly dismissive of 'corporate social responsibility' as a contradiction in terms – corporations should not be expected to have public aims.

Interestingly, the examples of local government in the US show a huge variety of choices being made by different municipal authorities in terms of their relationships with the private sector. It's not clear what drives these choices. I think the authors pay too little attention to the role the public can play directly in determining how different services should be run. If government authorities lack enough information to undertake activities themselves, one source of information is direct consultation with voters. This 'process justice' is an essential part of creating public value (as I argued in Public Value in Practice).

A final quibble – this is a book about the United States which does limit its interest for non-Americans. The discussion of charter schools has some relevance for the UK now but a lot of the examples are less relevant. Nevertheless, there's plenty of interest in the general discussion for policy wonks everywhere.

Authors don't come much 'bigger picture' than Francis Fukuyama, author of The End of History. It doesn't seem to matter for his reputation that as it turned out history was just beginning. And actually, his later book Trust was very interesting indeed for the political science perspective on social capital. Now, out next month, is The Origins of Political Order. I'm sure I'll enjoy reading it whatever he says, having a weakness for the big picture genre. Recently I enjoyed Ian Morris's Why The West Rules for Now. And I'll be particularly interested to see how Fukuyama compares to the stellar Company of Strangers by Paul Seabright.

Meanwhile, here is a feature about The Origins of Political Order in the New York Times. I'm sure there will be a lot of reviews before long.

 Ed Crooks has written a very enjoyable review (registration required) in this weekend's Financial Times of several new books about the prospects for American economic recovery. He paints each of them – The Next American Economy, by William
Holstein, The Comeback: How Innovation Will Restore the
American Dream, by Gary Shapiro, Make It In America: The
Case for Reinventing the Economy, by Andrew Liveris, and Advantage: How
American Innovation Can Overcome the Asian Challenge, by Adam
Segal  – as examples of a familiar genre. That is the 'how can the US overcome the challenge of X's bid for economic supremacy,?' the challenger for the previous generation being Japan, and for the current lot, China.

Some of those books were dire, and I'm not massively encouraged by the FT review to read any of the new generations. Ed Crooks writes:

“None
of the books is perfect. They mix fresh and thought-provoking insights
with tired political talking points. They praise the authors’
achievements, in passages that must be more rewarding to write than to
read. They share a perplexing fascination with the work of The New York
Times columnist Thomas Friedman, and they are ready to criticise
economists while apparently knowing little about what they actually
think.”

He does say each has its good points, and one should always read with a mind open to new ideas. However, the fundamental flaw with this whole genre is the idea that countries are in a race with winners and losers. When it comes to economies, each can win. One of my least favourites was Lester Thurow's The Zero Sum Solution, not least because of its title. Michael Porter's The Competitive Advantage of Nations has something to answer for too, as it transferred his rightly esteemed model of competitive rivalry between companies to the stage of national rivalry.

Mutual gains from trade, hello! Americans will do much better to worry about their own investment in skills and infrastructure, and the quality of the economic institutions of the US, rather than fretting about China 'overtaking' them.

Recently I reviewed Beyond Mechanical Markets by Roman Frydman and Michael Goldberg, and yesterday had the opportunity to meet Roman Frydman to discuss the book. He told me that many financial economists and many who work in the financial markets find it hard to understand the key point they are making in the book. It is that uncertainty about the world is so pervasive that the idea of 'fundamentals' or a 'true model' makes no sense. Today, the price of oil is important to share prices, but it wasn't 5 years ago and it might or might not be in another five years' time. Who knows?

This seems obvious, but has big implications. If there's no true model, it isn't possible to have rational expectations about it. The efficient markets hypothesis is meaningless. Indeed, there is a logical inconsistency in the rational expectations approach, because either the market in the aggregate delivers 'rational' outcomes in which case each individual investor is separately wrong; or all individual investors are right but identical. Many readers will be nodding in agreement (although not all). Equally, though, if there's no 'true' model, there's no need either to argue that financial market outcomes are determined by 'irrational' investors, which is what most behavioural finance approaches imply. As Prof Frydman put it, the rational expectations/efficient markets approach assumes investors are right about the true model;  while the behavioural approach acknowledges the inconsistency I just described but instead assumes that investors are (for psychological reasons) wrong about the true model. Both posit a true model – and that is what he is challenging with 'imperfect knowledge economics'.

Intriguingly, he argues that the conventional approach of financial economics is philosophically identical to central planning. Both assume the economist/planner can take an objective bird's-eye view of the fundamental structure of the market or economy. (It put me instantly in mind of Francis Spufford's marvellous book Red Plenty.) Instead, the world is contingent and investment opportunities temporary – which is exactly why people in the markets are obsessed with gathering information.

I will definitely go back to Beyond Mechanical Markets and in particular the philosophical Epilogue that I skipped over on my first read through. Prof Frydman told me that the book has struck a chord in continental Europe and has intrigued commentators in the UK, but is making less headway in the US. Maybe the cognitive dissonance between his arguments (and recent events) and the beliefs financial economists have held for three decades is just too strong?

Coffee in London with Prof Roman Frydman, 25 March 2011